The Folly of State Subsidies, Part Two

A new study released this week by the Pew Center for the States is further proof of the folly of state tax incentives as a way to attract job-creating business – though in its usual even-handed fashion Pew is careful not to say as much. The report shows that surprisingly few states make serious estimates of the potential cost of tax incentives they offer companies, and very few cap the total benefits, leaving the government exposed to large losses.

The results can be shocking. According to Pew, Louisiana’s tax break for horizontal oil and gas drilling, which cost just $285,000 in 2007 before the technology was fully developed, cost the state $239 million in 2010. Hawaii’s tax credits for renewable energy leapt from $34 million in 2010 to an estimated $260 million next year.

In the wake of last week’s New York Times series cataloguing the roughly $80 billion in tax incentives and other subsidies to business over the past five years,  I’ve been looking further into whether anything sensible can be done to save state and municipal governments from themselves. It turns out there was one half-hearted attempt, led by former Illinois Republican governor Jim Edgar, as the economy was just coming out of recession in the early 1990s. The catalyst was an out-of-control competition to win construction of a new aircraft maintenance facility by United Airlines. Some ninety cities competed for the $800 million investment, which promised 6,300 jobs paying an average of $45,000 per year.

Indianapolis won, with a combined incentives program that added up to $294 million, beating out both Colorado and Kentucky which had actually come up with even larger packages.

The AP’s 1992 account of the fight is so good that it’s worth quoting at length:

The other finalists felt they’d lost a no-limit, stare-you-down poker game; though others offered higher bids, United chose Indianapolis due to the mix of incentives, location and other factors.

Colorado topped out at $340 million. House Majority Leader Scott McInnis grumbled that “United has a ring and is pulling Colorado by the nose.”

Kentucky folded in its hand at $341 million in cash, land and tax abatements. Gov. Wallace Wilkinson said United wanted to “prolong it to the point where they were sure they had squeezed every drop of blood out of every turnip.” [End Quote]

Robert  Reich of Harvard, who was later to be appointed as President Bill Clinton’s labor secretary, was quoted saying that “the competition is getting out of control.” You think? The AP story added: “When times are tough, a certain desperation enters into the bidding. The competition is cut-throat. And good sense goes out the window.”

Indiana won the battle despite facing large state and local budget deficits, in effect forcing the state to raise other taxes or cut services to attract United. The ironic upshot was that United remained for barely a decade, leaving and consolidating its maintenance operations in San Francisco when the airline ran into financial trouble in 2003. And even before United left, the facility never created anything like the promised 6,000-plus jobs, instead topping out at about 1,200.

Governor Edgar of Illinois, whose state was one of the fortunate losers in the bidding war, tried to persuade his fellow governors to take a serious look at what he later called “this whole smokestack chasing business.” He never got very far. The closest was a sort of truce among New York, New Jersey, and Connecticut not to run ads aimed at luring away business from their neighbors.

Gov. Edgar later argued that states were making a big mistake showering tax subsidies and other goodies on companies. Much better, he said, to focus on improving the quality of life in your state and make it somewhere that smart people want to live and work – much as my colleague Jonathan Masters noted in his post earlier this week on Oklahoma City’s wildly successful revitalization.

A better role role for government, Edgar said, is to focus on infrastructure and job training. “I’m not in favor of giving tax incentives or cash or these kinds of things,” he said. “I want something that if you [the company] decide to walk, we’re going to be able to keep. Infrastructure we keep, and a better workforce we keep.” That is much the same conclusion that economist Roland Stephen reached earlier this year in his superb Renewing America working paper, “After Manufacturing: Lessons for a New Reality from North Carolina.” More states should start listening.